| These were quite popular in India, but the change in currency values has changed things. |
| The so-called "carry trades" have been a favourite ploy of international investors and hedge funds. Incidentally, calling such traders "investors" unnecessarily glorifies the activity of what is, all said and done, speculation. The journalistic distinction is that if you are successful in speculation, you are praised as an investor as, say, George Soros is "" if you fail, of which there is an equal chance, then you are branded a greedy speculator. |
| "Carry trades", involve borrowing in low interest currencies, and exchanging them for, and investing in, currencies which have high interest rates or yields. There is an obvious exchange risk, and it cannot be hedged if the trade is to result in a profit. (Given the interest parity principle in the foreign exchange market, the forward margin would nullify the interest differential.) The "investor" therefore takes the exchange risk, but hopes to gain if the borrowed currency is either stable or weakens in relation to the invested currency "" in the latter case, you make money not only through the interest differential but also on the exchange rate. You would lose only if the borrowed currency appreciates more than the interest rate advantage of the trade. |
| Carry trades have been in the news recently as the international interest and exchange rate scenario has changed. The recent fall of the high interest rate currencies of Iceland, Hungary, and Turkey is attributed to the reversal of carry trades. "Carry trades" were also popular with the comparatively high yielding New Zealand dollar as the investment vehicle. But both the Australian and New Zealand dollars depreciated in the first quarter of the current year in dollar terms. The trend has reversed in April with the general weakness of the US currency against almost all others. Indeed, the recent weakening of dollar has provoked at least some analysts to contemplate that horror or horrors "" namely, that markets may have started focusing on structural and fundamental problems like the US trade gap. |
| In any case, at least some central banks seem to be getting worried about the medium term prospects and are reducing exposure to the dollar. Such central banks include those of Sweden, Russia, Qatar, the UAE and Kuwait. The "big gorillas" are, of course, the east Asian central banks. The Chinese and Japanese central banks by themselves probably hold half the world's reserves of foreign exchange. The big question in terms of the fate of the dollar is whether (when?) China and Japan would follow some of the European and middle-eastern central banks. The IMF has now been given the task of multilateral surveillance of exchange rates "" in other words, to facilitate cooperative action on the part of different countries and their macro economic policies, in order to reduce "global imbalances" (that is, the US deficit). It seems a very tall order for the IMF to persuade the US to cut its budget deficit or the US consumer to save more, which will be necessary if Plaza 2006 is to work. In its absence, trade protectionist lobbies in the US will gain strength, with all that this may entail for global growth. |
| But to come back to carry trades, the most spectacular impact of their reversal was seen in the yen:dollar market in 1998. For a few years, a popular and lucrative trade was to borrow yen, buy dollars and invest in US treasuries. Not only was the interest differential very attractive, but the yen moved from ¥79 to a dollar in April 1995, to ¥147 in summer 1998. What triggered a change in the scenario was the collapse of LTCM, the highly leveraged hedge fund, leading to banks cutting down their credit lines to all hedge funds. They were thereby forced to reverse the trades by buying yen and the yen moved from ¥136 to ¥112 in a couple of days, the most spectacular exchange rate change I have witnessed. |
| "Carry trades" are hardly unknown in India "" except that they are trade-linked and not merely financial transactions. For instance, foreign currency credit on imports, and to that extent borrowing less rupees (or adding to invested rupee surpluses), leaving the exchange risk uncovered, is also as much a "carry trade" as what hedge funds undertake in financial markets. Such trades were very popular and profitable with Indian corporates when dollar interest rates were much lower "" and the rupee was appreciating. Both factors have changed recently, and one is seeing that the corporate sector is now less enthusiastic about taking large dollar exposures. If the trend gathers momentum, it has serious implications for both interest and exchange rates. |
| Tailpiece: This paper reported last week that Attorney General Milon Banerji advised the government not to sell its residual equity in BALCO to Sterlite Industries as the, "price set by SBI Caps does not reflect the current value of the company". Evidently, Banerji is also an investment banker!
Email: avrco@vsnl.com |
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